Quantitative Easing Case Study
1) How does QE operate?
QE was firstly conducted by Bank of Japan in 1990s to combat deflation, and then this unconventional monetary policy has been extensively used by central banks around the world post 2007 financial crisis. The design of QE can vary by countries, and typically involves large scale purchases of long-dated government bonds financed by the central bank in the secondary market, aiming to reduce long term borrowing costs to support growth and inflation particularly …show more content…
Although the magnitude of the effect varies markedly in different countries, majority of the studies collected by Gagnon (2016) concluded that an equivalent of 10% of GDP QE can drive down 10 year government yields by a median of 45-55bp for USA and UK. In addition, studies found that the drop in the yields of government bond can spill over into lower corporate bond yields and weaker exchange rates (Neely, 2012; Glick and Leduc, 2012 etc.).
On the other hand, the transmission of a lower borrowing cost to an increase in investments, and thus aggregate demand growth. For example, during periods of uncertainty and low confidence, firms can be reluctant to invest and individuals can be declined to spend.
A number of empirical evidences have supported the macroeconomic effects of QE despite the magnitude of the impacts are controversial. Gagnon (2016) argued that the cumulative rounds of QE in USA have reduced the unemployment rate by more than 1% as of early 2015 and boosted inflation by about 0.5%. Further, Joyce and at el (2015) estimated that QE in UK had a cumulative effect equal to a cut in the short-term interest rate of 1.5% to 3%. Additionally, QE seems to be less effective in Japan in terms of lowering down the yields and driving up inflation, …show more content…
Note here that commercial banks only serve as an intermediary in the QE transaction and the amount of new reserves is matched by liabilities in the form of deposits. The theory of bank lending channel argues that QE expands commercial banks balance sheet and drives down the deposit / reserve ratio, providing incentives for banks to issue more loans as a lower deposit / reserve ratio means a higher return of loan. The increase in the broad money should lead to inflation and economic